Saudi Arabia's Stock Market Plunges

Stock market traders in Saudi Arabia got a bit of a wake-up call yesterday. Their stock market evidently sees something it doesn't like. Why the market is all of a sudden more worried than it was previously about the challenge to the established political order in the Arab world is a bit of a mystery, but presumably traders have thus far deluded themselves into thinking that Saudi Arabia would be immune to unrest. Something has evidently changed their mind. It seems to us that this event deserves the moniker 'warning sign'. The selling has been extremely heavy for three days now. Since this market is largely driven by local investors, we should probably attach some significance to this recent plunge. Someone has begun to sell three days ago and has spooked the herd. It's a good bet that the someone who started the selling is better informed than the rest of us.

Note in this context the following information about the current oil policy of Saudi Arabia from Marketwatch. While the article references anonymous sources, which stands in the way of fact-checking, there is one paragraph that caught our eye:

„“The main threat is . . . Saudi instability when the current king dies. We know he is very ill but obviously there is no indication of how critical that condition is. But it is acknowledged that the next transition will present a much bigger threat to internal stability. . . . Vested interest groups have been waiting for this transition to push their agenda. Saudi experienced considerable regional instability up to 10 years ago but bought it off with higher oil-based spending. Today the problem is as bad, if not worse. There have been only a few of the promised reforms. . . . Resentment towards the wealth gap with the royals is very high. . . . Even if/when the instability in other countries, such as Libya, settles, the Saudi succession threat is now firmly on the table. What happens in Bahrain could be very key. That alone will keep the oil market nervous for this year.”

The very ill king could in fact be the key to the sudden crash in Saudi Arabia's stock market. With political instability across the entire region, a fight for succession in Saudi Arabia wouldn't be very conducive to stability at this particular point in time. The fact that spreading some of the oil wealth around has not been effective in lowering the level of resentment vis-a-vis the royals sounds very credible to us. So does the assertion that what happens in Bahrain will be very important. Bahrain is ruled by a monarchy as well and should it lose power, the Saudi masses could be galvanized.

Saudi Arabia is the world's second biggest oil producer after Russia and as a result the monarchy has enormous financial resources at its disposal. This certainly helps with buying off numerous special interest groups. Also, as we mentioned in passing previously, the royals have a deal with the powerful and highly conservative religious establishment that helps keep them in power. Essentially the country is a mixture between a monarchy and theocracy. The strict religiously inspired laws may on the one hand sit well with the deeply religious population, but on the other hand they also make for a very repressive environment that may sit less well with the youth – large numbers of which are unemployed. Also, the extravagance of the many Saudi princes (over 10,000 royals are about, all well-endowed with stipends) may not go down all that well with the rest of the Saudis, regardless of what deals the royals have made with the mullahs. All in all, it remains a potentially explosive situation.

In the meantime, Muammar Qaddafy continues to give utterly bizarre interviews (if anything, they have become even more so…'I don't lead Libya, I have no power'…'The people of Libya love me!'), while more and more of Libya falls to opposition forces. Evidently the man has lost whatever connection to reality he may once have possessed. The Pentagon has meanwhile assembled naval forces off Libyan waters – possibly to enforce a no-fly zone.

While all eyes are on Libya, Egypt has once again decided not to reopen its stock market – the reopening of the stock exchange has been postponed repeatedly, so this is almost business as usual by now.

„The Egyptian Exchange, shuttered for over a month, was to resume trading on Tuesday. But in an overnight statement, exchange officials said the market would reopen instead on March 6 to "allow investors to profit from the government's support to guarantee stability in the bourse."

The decision reflected the strong undercurrent of unease in the Arab world's most populous nation where the market's benchmark stock index had shed almost 17 percent in two consecutive trading sessions before it closed at the end of the business day on Jan. 27.“

Keep the market closed to 'allow investors to profit from the government's support to guarantee stability in the bourse'? Good luck with that one.

As a final note on the Middle East, we continue to recommend keeping an eye on Iran. The regime is evidently worried, and given Iran's importance as an oil exporter, any unrest in that country would arguably have an even bigger effect on the oil market than Libya's recent disintegration.

“As Irish voters headed for the polling booths on Friday, the European Commission bluntly declared that the terms of the EU-IMF bailout "must be applied" whatever the will of Ireland's people or regardless of any change of government.

"It's an agreement between the EU and the Republic of Ireland, it's not an agreement between an institution and a particular government," said a Brussels spokesman.

A European diplomat, from a large eurozone country, told The Sunday Telegraph that "the more the Irish make a big deal about renegotiation in public, the more attitudes will harden".

"It is not even take it or leave it. It's done. Ireland's only role in this now is to implement the programme agreed with the EU, IMF and European Central Bank. Irish voters are not a party in this process, whatever they have been told," said the diplomat.”

(our emphasis)

Hello? Irish voters are 'not a party in this process'? Irish voters – i.e. the tax cows that have been condemned to bail out their failed banks so that the highly leveraged German banking system can avoid a debt restructuring broadside – may well go from 'revolution lite' as the WSJ calls the election outcome (since essentially, one conservative party was exchanged for another), to a 'real revolution'. As an aside, while the WSJ asserts that 'Ireland needs Merkel', we believe it is exactly the other way around (see further below as to why). Our understanding of 'democracy' is that voters are the ultimate arbiters of such things. There is no agreement that can not be amended or broken if voters feel they have been sold out by the government that signed it. As the Telegraph notes further:

“Dessie Shiels, an independent candidate in Donegal, said: "People have not been given the basic right of deciding whether or not they should have their taxes increased in order to repay bondholders who have lent to the banks."

David McWilliams, an economist and former official at the Ireland's Central Bank, has led calls for a popular vote under Article 27 of the Irish constitution, which requires on a matter of "such national importance that the will of the people ought to be ascertained".

"We have to re-negotiate everything," he said. "Obviously, the first way to do this is to make them aware that if they force us to pay everything, we will default and they will get nothing. So they had better get a little bit of something, than all of nothing. To make this financial pill easier to swallow, we must take the initiative politically. We can do this via a referendum.

"If the Irish people hold a referendum on the bank debts now, we can go to the EU with a mandate from the people which says No. This will allow our politicians to play hard-ball, because to do otherwise would be an anti-democratic endgame."

Declan Ganley, the Irish businessman who led the 2008 No vote to the Lisbon Treaty, said Ireland must "have the balls" to threaten debt default and withdrawal from the single currency.

"We have a hostage, it is called the euro," he said. "The euro is insolvent. The only question is whether Ireland should be sacrificed to keep the Ponzi scheme going. We have to have a Plan B to the misnamed bailout, which is to go back to the Irish Punt."

(our emphasis)

Got it in one, Mr, Ganley. Ireland is the party that has the leverage in this situation, not the EU. The decisive point is this: The euro is a kind of 'roach motel' – it's easy (too easy) to get in, but it is very hard to get out.

Why is it so hard to get out? It isn't, as the outgoing Irish government asserted, the fact that government would find it hard to borrow money in the markets after a bank debt restructuring, or even after a restructuring of the government's own debt. Greece, which has been bankrupt for half of the past 180 years, is proof positive that it is fairly easy to find new suckers for government debt after a while.

No, at the root of the 'roach motel problem' are the banks themselves. If the population suspects that an abandonment of the euro is imminent, worries that the national currency likely to succeed the euro will be devalued would provoke a flight from the banks – depositors would shift their deposits to other banks somewhere else in the euro area. Both Greece and Ireland have in fact been plagued by such a flight of depositors already, to varying extent. In fact, the biggest and quite obviously bankrupt Irish banks have bled deposits at an enormous rate lately. With the banks completely zombified, worries about a flight of depositors should be much reduced – since they have already largely fled.

The banking system is however also a big worry for the rest of the EU. Why was the Irish government forced to accept a bailout? What was so urgent? Why was it so important to especially avoid a restructuring of the senior debt of Ireland's banks? The answer is that an Irish debt restructuring imposing a big haircut on bondholders would hit banks elsewhere in the euro area (including the ECB, as it were). The way we see this, Irish voters will eventually prove the arrogant unnamed European diplomat from 'a big country' wrong. They will eventually be a 'party to the proceedings'. Negotiating a lower interest rate on borrowings from the EFSF, the currently enunciated goal of the new Irish government won't be enough. It won't do the trick because the burden will still be too large.

We would note here, as we have repeatedly done before, that it does no-one any good to pretend that losses don't exist or that the giant fiat money Ponzi scheme made up of unpayable government debt and de facto insolvent fractionally reserved banks can be forever kept going by heaping new debts atop the old ones. If we want genuine, sustainable economic growth to resume, the only way to achieve that is to bite the bullet. Acknowledge the losses and let them fall upon those who have invested unwisely. This is not merely a question of morality, as prominent Keynesians like Paul Krugman keep saying. It is a question that concerns the system of free market capitalism itself. Capitalism is not supposed to privatize profits and socialize losses. This is a perversion of the free market system that will ultimately serve to destroy it.

In addition, as the EU lurches toward the 'big accord' planned for late March – a.k.a. the 'Grand Bargain' (Portugal may well fall into crisis before that date, as its bond yields remain stuck above the crucial 7% level and large debt rollovers are awaiting it in March), there are evidently plans afoot to 'make other European nations more like Germany'. Unfortunately this is not merely about fiscal rectitude as such. It is also about the desire of the German political class to impose Germany's high taxes on everyone. Ireland would do well to think twice about agreeing to such stipulations.

Portugal's 10 year bond yield sits at 7.45%. Greece and Ireland both became EFSF wards when their yields crossed the 7% mark. And yes, this is a bullish (bearish for Portuguese debt) chart.

The Markets

The Stock Market

In the wake of the big decline in Saudi Arabia's stock market, other stock markets also suffered a bad hair day. It would be easy to pin the blame for the stock market's recent decline on the problems in the Middle East, but bulls should perhaps be more concerned about a number of other facts. For one thing, there is the subtle internal technical deterioration as evidenced by many 'momo' stocks coming under pressure of late, i.e., the so-called 'Teflon stocks' all of a sudden look somewhat less teflonesque. A similar point is made in a recent article by Michael Kahn at Barron's about the Dow Jones Industrial Average. As Kahn remarks:

“Despite its limited representation in a market of thousands of stocks, the Dow Jones Industrial Average nonetheless is an important barometer. Given the sheer dollar value of its 30 component issues, any cracks in its armor should not be ignored.

So when fully one fifth of Dow stocks sport technical failure we should take notice. Failure, in the lexicon of charting, is often used to describe a stock falling as it hits a key level such as resistance or the top of a pattern.

When a stock breaks out to the upside from resistance or a chart pattern it is usually a bullish sign. Demand overcomes supply and prices move higher – most of the time. However, failure to hold on to that breakout is the unusual case and that makes it a true newsworthy event for investors.”

Kahn notes that the bulk of the DJIA stocks remains in solid uptrends, but of course when the market gets into trouble, the first signs of such are always subtle.

What is notable to us about the recent decline is that the preceding rally as well as the recent rebound all happened on very weak volume, whereas volume tends to spike when the market moves lower. This is a negative sign too.

What else should stock market bulls worry about aside from the loss of leadership and subtle signs of technical deterioration? How about 'Hedge funds borrow the most since 2007 to purchase US stocks'?

“Hedge funds increased their net leverage in January to the highest level since October 2007, as they took advantage of record-low borrowing costs to bet that the U.S. equity rally will continue.

Debt at margin accounts at the New York Stock Exchange minus cash and unused credit from margin accounts climbed to $46 billion, according to data released by NYSE yesterday. Hedge funds had $290 billion of debt from margin accounts in December, the largest sum since Lehman Brothers Holdings Inc. collapsed in September 2008.”

(our emphasis)

Needless to say, October of 2007 was not exactly a propitious time to buy lots of stocks on margin. Perhaps this time will be different, but we kind of doubt it (although in some respects the 2007 high was even more beset by extremes – but then, it was a much higher high).

“The biggest Standard & Poor’s 500 Index rally in more than five decades is forcing stock market bears to abandon short sales, cutting them to the lowest level since 2007 last month.

Shares borrowed and sold to profit from declines dropped four straight months and represented 3.3 percent of all stock in January, according to data compiled by NYSE Euronext. Pessimists are giving up after missing the 95 percent rally in the S&P 500 spurred by the fastest earnings growth since 1994. The monthly decrease comes as individuals added $17.6 billion to U.S. mutual funds this year after withdrawing money since April.”

(our emphasis)

There it is mentioned again, that fateful year 2007. Capitulating bears weren't a good sign then, and they are unlikely to be a good sign now. The lower the short interest ratio, the less support from short covering there will be once the market heads down, but to us it is more important what this datum says about sentiment.

The chart of the high beta DJ Transportation average is intriguing – its rebound failed at the 50 day moving average. This average generally tends to lag in moves up (i.e. it tends to be one of the last indexes to top out) and lead in declines.

A recent chart of mutual fund cash levels from Jason Goepfert's sentimentrader.com shows that mutual fund managers are also 'all in' – the current reading is the second lowest in all of history, a mere 10 basis points above the all time low (the absolute low was seen in 2010). This indicator tends to have medium to long term significance. We see it largely as an expression of fund manager sentiment.

Solely from a chart perspective it is too early to say whether the recent pullback will just be a short term hiccup or the beginning of a more substantial correction. Many of the aforementioned momentum stocks have weakened, but they have not yet broken any important supports. However, the fact that the market has for a change not rallied on the first of the month (the bulk of the advance from the 2009 low was accomplished by large first-of-the-month rallies) clearly constitutes a change in character.

Apart from that, the fact remains that risk is extremely high. Should the market rebound and streak to new highs for the move, said risk won't diminish, but will become even greater.

Gold and Oil

Not too surprisingly, both oil and gold have continued their rallies. Gold is on the verge of a decisive breakout, while the oil market appears close to negating a recent reversal candle (as we noted at the time, such reversals require follow-through selling to be confirmed as such).

It appears that oil wants to go even higher. Since the reversal candle that was put in place four trading days ago has not led to follow-through selling and the market is already bouncing higher again, no reversal has been confirmed as of yet. Of course this is now a market harboring a large 'political risk premium', which makes it extra-risky (for both bulls and bears). Nothing's wrong with this chart though.

We are not certain how much of a political risk premium there is now in gold, but gold seemed to us already set to make new highs before the news about the unrest in Arab countries took center stage (we have frequently remarked on the subdued bullish sentiment after the small correction in January).

One must not forget, when central bankers stubbornly defend ultra-easy monetary policies as Mervyn King and Ben Bernanke both keep doing, then there is little reason not to want to own gold (we will soon have more to say about the recent statements by these two gentlemen – neither of them managed to disappoint our expectations, which are even lower than their interest rates). Also, with the bulk of gold's fundamental price drivers in a bullish configuration, the backdrop remains conducive to higher gold prices regardless of the geopolitical noise (it is to our mind different in the case of crude oil).

Both gold and silver (solid line) streak higher. Gold's close actually constitutes a breakout, but it is not a decisive breakout yet. As previously noted, gold 'doesn't do triple tops', so a decisive breakout seems highly likely.

The US Dollar

The dollar rates a mention for its failure to profit from 'safe haven buying' in view of the news from the Arab world. It may be that talk of the allegedly 'undiminished likelihood of QE3' isn't helping, especially as ECB officials have lately adopted a fairly hawkish tone. Of course, money supply growth in the euro area has in recent months been far lower than money supply growth in the US, so there is a good reason for the euro to show some relative strength based on that, but the problem of the unresolved debt crisis remains – which argues strongly against the euro going forward. Be that as it may, the dollar hasn't been going anywhere lately. We would however not be inclined to get too bearish on the US dollar here, in spite of its failure to attract safe haven buying. The recent decline has been grudging, which is often the precursor to a short term trend change.

The US dollar hasn't been helped by turmoil in the Middle East – which is a bit surprising.

Finally, before it is out of date, we want to point readers to a recent interview by the 'father of securitization', Lew Ranieri, on the state of the US housing market. He echoes the concerns that Ramsey Su has enunciated in these pages. The US housing market remains quite sick, in spite of the wagon-loads of money Ben Bernanke's Fed has printed. An old adage is confirmed by this fact: the central bank can print money, and/or encourage the commercial banks to increase the credit and money supply, but it has no control over where this money ultimately goes.

Charts by: Bloomberg, StockCharts.com, Sentimentrader.com

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2 Responses to “A Crash In Saudi Arabia, Arrogant Eurocrats and a Look at the Markets”

For me, that low volume is saying; ‘everyone who was going to execute a trade, has executed’. Now the question is; where’s the loser? Looking at your mutual fund cash % chart and margin debt it looks like the loser is long.

Much of this up move has been characterized by low volume. During selloffs it picks up only to fall back again during the next up leg. So low volume by itself has told us little to date.

I figure this is either a November or April scenario. If the former we may be done or could see one more push down to the 50 DMA before heading higher. If the latter the market will crumble shortly or immediately after closing decisively below the 50 DMA.